Trading price signals instead of emotional signals
“Dramatic and emotional trading experiences tend to be negative. Pride is a
great banana peel, as are hope, fear, and greed. My biggest slip-ups occurred
shortly after I got emotionally involved with positions.” – Ed Seykota
It is said that over 90% of active traders in the financial markets don’t make
money over the long-term. There is a lot of confusion about the exact numbers,
but it’s safe to say that it’s difficult to be profitable over time.
Even investors
have terrible timing on their buy and sell decisions, but why is this the case? It
typically comes down to emotions.
The majority of the errors that traders and investors make are emotional ones
because they rely on internal signals. Their emotions give birth to a buy and sell
strategy that is unproven and often unprofitable. We’ve witnessed this as many
of the wild price swings that make no sense in the current market environment.
If you want to make a quantum leap in profitability,
the first step is to stop
buying or selling anything without a solid, quantifiable, external reason for
doing so.
Greed was the primary driver of the NASDAQ 5000 bubble in March of 2000,
not the valuations of ‘eyeballs’ on websites. Buyers continually piled into dot
com stocks with no real intrinsic value, and held them
due to the greed of more
gains and higher highs. The NASDAQ 5000 trend could have been traded
profitably with the right entry and exit signals. Simple chart patterns and moving
averages made many traders a lot of money in 2000. I had enough money in
March of 2000 to pay off my new house when I was 27 years old, and I have
been hooked ever since.
The problem during this period was the traders and
investors that traded based
on their personal euphoria that allowed them to hold their positions during the
parabolic tech uptrend, didn’t allow them to lock in profits and exit their
positions. Using trailing stops would have helped them exit and keep large gains
instead of riding their tech stocks all the way back down.
In March of 2009 all major stock indexes made lows that seemed impossible just
a year before. The selling escalated because
of a fear of holding equities, and
sellers were willing to let go at ridiculously low prices. Long-term trend traders
should have been out of the long side of stocks and limited losses in 2008 using
any reasonable sell.
The easiest sell signal for a trader or investor to use to limit the destruction of
their capital is to exit their holdings and go to cash when the S&P 500 index
tracking ETF SPY closes under its 200-day simple moving average. For stock
indexes, this one simple exit signal decreases drawdowns of capital by about
50% in the past 15 years of backtests. It doesn’t increase the returns in most
cases, but exiting when the 200-day simple moving
average is lost will cut the
down side in half.
You have the option to be in cash during market corrections, bear markets,
recessions, and market meltdowns, and you can wait to start buying again when
the indexes start closing over the 200-day.
This could be the most important
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